Venture firms talk a lot about their keiretsu, their networks of portfoli=
o
companies. These associations of companies supposedly allow entrepreneurs
within a given venture firm's portfolio to share important new technology
and information. But there is another type of keiretsu in the venture wor=
ld:
the entrepreneurs fund.
An entrepreneurs fund is a side fund in which CEOs or other valued contac=
ts
can invest; essentially, people invited to participate in these funds can
invest in the same deals as a venture capital firm. Fund structures vary
widely, but the total amount of capital committed to an entrepreneurs fun=
d
is typically limited to five percent or less of a firm's main fund. Since
entrepreneurs funds are so small, participants in these funds cannot rake=
in
as much money as a venture firm's limited partners. But unlike limiteds,
entrepreneurs do not have to pay a carry or a management fee. (A carry is=
a
fee that venture firms charge against the gains on a limited partner's
investment; this amount can range from 20 to 30 percent. Venture firms al=
so
charge a money management fee of one to two percent of the total fund.) M=
ost
firms also do not limit entrepreneurs from participating in other firms'
funds. Kleiner Perkins attributes its success to its investment keiretsu.
Accepting angel investment holds rewards and risks for a company. Of cour=
se,
taking venture capital isn't risk-free, either. Because of these favorabl=
e
economics, entrepreneurs can make out quite nicely. According to John
Walecka of Brentwood Venture Capital www.brentwoodvc.com, returns for
Brentwood's entrepreneurs have averaged in excess of 100 percent, thanks =
to
investment home-runs like Rhythms NetConnections (Nasdaq: RTHM), NextCard
(Nasdaq: NXCD), and Concur Technologies (Nasdaq: CNQR). Brentwood is
currently raising a $12 million entrepreneurs fund.
Kathryn Gould of Foundation Capital www.foundationcapital.com thinks
entrepreneurs funds have played an important role in persuading
entrepreneurs to become angels. She also says they represent an important
resource for her firm's portfolio companies, which can benefit from these
investors' contacts and experience. Still, a small minority of VCs told m=
e
they thought entrepreneurs funds posed ethical problems. No matter how sm=
all
an entrepreneur's investment in one of these funds might be, one venture
capitalist told me, firms with entrepreneurs funds are effectively denyin=
g
their limited partners a percentage of a deal. Another VC complained that
his firm did not really derive enough benefit from its entrepreneurs fund
participants to justify its entrepreneurs fund, while a third venture
investor echoed this gripe: he called entrepreneurs funds a form of
"organized graft."
ENTREPRENEURS ASCENDANT
Andrew Anker of August Capital www.augustcap.com defends entrepreneurs
funds. "The investors in the entrepreneurs fund are people who are bringi=
ng
us deals and building the companies in which we invest," he says. "We are
not rewarding people who have no attachment to the success of our main
fund." Ms. Gould also supports entrepreneurs funds, but admits that her
firm's entrepreneurs fund is growing bigger every year. She speculates th=
at
these side funds may become so large that they will become an important
investment force in their own right.
In a certain sense, entrepreneurs funds have already outgrown their humbl=
e
beginnings. In the past, venture firms raised the majority of their gener=
al
funds from colleges, pension funds, and financial institutions. But for i=
ts
current fund, Kleiner Perkins Caufield & Byers www.kpcb.com has collecte=
d
more money from partners, entrepreneurs, and friends of the firm than fro=
m
institutions. This development is undoubtedly related to the evolution of
Kleiner's entrepreneurs fund: because Kleiner's entrepreneurs can only
contribute a limited amount of money to the firm's entrepreneurs fund, a
select few decided to participate in Kleiner's general fund in order to b=
e
able to commit more capital. One VC I know wonders what will happen to t=
he
institutions if entrepreneurs continue to crowd them out of venture funds.
But I am more curious about what effect this evolution will have on ventu=
re
investing. Will entrepreneurs be able to hang tough if the market suddenl=
y
turns? Also, since entrepreneurs do not have the same fiduciary
responsibilities as institutions, will they encourage VC firms to take
increasingly risky positions?
The growth of the angel community has been great for startups. But the
increasing size of entrepreneurs funds may portend an even greater shift =
in
the VC world in the days and months to come.
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335